Emerging market bank lending and credit risk control : evolving strategies to mitigate credit risk, optimize lending portfolios, and check delinquent loans PDF
Preview Emerging market bank lending and credit risk control : evolving strategies to mitigate credit risk, optimize lending portfolios, and check delinquent loans
Statement In writing this book, the author relied on his wealth of banking experience, research and consulting spanning nearly a quarter of a century. However, advice and instructions he proffered are strictly personal, subject to indepen- dentverification,anddonotsubstituteforpersonalinitiativeandduediligence in entering into banking relationship and transactions or in making financial investments. There is always risk in following general advice without obtaining direct independent research with respect to financial investments, ifanything.Thustheauthorandpublisherarenotliableforanyloss,financial or otherwise, in applying advice, instructions and principles contained in this book. Emerging Market Bank Lending and Credit Risk Control Evolving Strategies to Mitigate Credit Risk, Optimize Lending Portfolios, and Check Delinquent Loans Leo Onyiriuba AMSTERDAMlBOSTONlHEIDELBERGlLONDON NEWYORKlOXFORDlPARISlSANDIEGO SANFRANCISCOlSINGAPORElSYDNEYlTOKYO AcademicPressisanimprintofElsevier AcademicPressisanimprintofElsevier 125LondonWall,LondonEC2Y5AS,UK 525BStreet,Suite1800,SanDiego,CA92101-4495,USA 225WymanStreet,Waltham,MA02451,USA TheBoulevard,LangfordLane,Kidlington,OxfordOX51GB,UK Copyright(cid:1)2016ElsevierInc.Allrightsreserved. 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Inusingsuchinformationormethodstheyshouldbemindfuloftheirownsafetyandthesafety ofothers,includingpartiesforwhomtheyhaveaprofessionalresponsibility. Tothefullestextentofthelaw,neitherthePublishernortheauthors,contributors,oreditors, assumeanyliabilityforanyinjuryand/ordamagetopersonsorpropertyasamatterofproducts liability,negligenceorotherwise,orfromanyuseoroperationofanymethods,products, instructions,orideascontainedinthematerialherein. LibraryofCongressCataloging-in-PublicationData AcatalogrecordforthisbookisavailablefromtheLibraryofCongress BritishLibraryCataloguing-in-PublicationData AcataloguerecordforthisbookisavailablefromtheBritishLibrary ISBN:978-0-12-803438-5 ForinformationonallAcademicPresspublications visitourwebsiteathttp://store.elsevier.com/ Publisher:NikkiLevy AcquisitionEditor:ScottBentley EditorialProjectManager:SusanIkeda ProductionProjectManager:DebbieClark Designer:MatthewLimbert TypesetbyTNQBooksandJournals www.tnq.co.in Dedication To My Mother and Children e With love About the Author Leo Onyiriuba’s books include “Analyzing and Managing Risks in Bank Lending” (2004), “Drive and Tasks in Bank Marketing” (2008), “Dictionary andLanguageofBanking”(2010),“CreditRisk:TamingaHotbedofReckless Banking” (2013), and “Banking Processing Risks and Control” (2014). Formerly a university lecturer, he runs a financial consultancy in Lagos, Nigeria, that helps clients succeed in their business, financial, and banking endeavors. xix Preface Motivationtowritethisbookcamefrommyexperienceasabankerfrom1991to 2003, during which I rose to the positions of divisional director (corporate banking)andmember(executivemanagement).Iobserved,studied,appreciated, andpluggedloopholesinlendingpracticesanddecisions.Ialsosawfirsthandthe agonyassociatedwithbankfailure,muchofwhichcouldhavebeenavertedwith sound credit policy, institutionalized lending culture, and responsible manage- ment of the risk assets portfolio. The problem was really overwhelming. I thoughtofwritingabookthatwouldchronicletheeventsleadingtoparticular bankfailuresandthelessonstheyheldforstakeholdersinbanking.Thoughthat madesense,onsecondthought,Iwasloathtowriteabookwithaheavyheart. YetIhadanoverwhelmingurgedwhichIcouldnolongerresistdtowritethe book.Thedearthoftextbooksthatsolelydocumentedtheintricaciesofthistopic boostedmyzealforthebook.Thefactthatseminars,workshops,conferences, and other such in-house and ad hoc training arrangements that banks use as fallbacks imparted only fleeting knowledge added to the boost. So I mustered confidenceandstartedwritingtofilltheobservedgap.Ironically,Itinkeredwith theoriginalconceptofthebookwhenIeventuallymadeupmymindtowrite. Thisbook,whichaddressesthornyissuesinbanklendingandcreditriskcontrol, istheeventualoutcomeofthetinkering. Twoofmypopularbestsellersmadetheprecursorsofthisbook.In2004,I publishedthefirst ofthetwobooksentitledAnalyzing andManaging Risksof BankLending. Thesuccessofthis17-chapter bookwasoverwhelming. It was reprintedin2005and2006beforeits30-chaptersecondeditionwaspublishedin 2008ewithareprintin2009.Theresoundingmarketacceptanceofthesecond editionwasremarkable.ThenIwasconvincedthatthemarketneededmorethan abroadbrushbookonthesubject.SoIdecidedtowriteacompaniontoit.The companion e Credit Risk:Taming a HotbedofReckless Bankinge published concurrently with the third edition of the first book in 2013 was no less well receivedbythemarket. However, there was a compelling need e soon after the companion was publishedetomergethetwobooks.Thatneedwasforanentirelynewbookthat would combine the contents of the aforesaid precursors into one strong, unparalleled, revised volume e covering emerging markets in Africa, Asia, Eastern Europe, and Latin America. The idea came to fruition with the pub- lishingof Emerging Market BankLending and Credit Risk Control. I imagine xxi xxii Preface that bankers, practitioners,analysts,academics,andstudentsaroundtheworld whohavereadandusedthetwobookswillsorelymissthem.Iadvisethemnotto mournthebooks’passing.Thenewbookthatsupplantsthem,EmergingMarket BankLendingandCreditRiskControl,issuperiorandoffersobviousgainsas reflectedinthispreface. OVERVIEW OF THE BOOK Bank lending and credit risk control can be likened to the American-type presidentialsystemofgovernment,onepoweredbystrongdemocraticvalues.In a presidential democracy, power is shared among three tiers of government and protected by clearly defined separation principles. The three tiers of governmentdexecutive, legislative, and judicialdfunction independently but under a checks-and-balances arrangement. Similarly, the crux of bank lending is usually three-pronged. This is depicted as the three Pillars of credit risk managementdcreditanalysis(Pillar1);creditpolicyandcontroldalsoreferred to as credit administration or credit compliance (Pillar 2); and loan workout, remediation,andrecovery(Pillar3). IsummarizethepurposesofthePillarsasfollows: Credit analysis institutionalizes processes for assessing lending risk and structuringacreditfacility.Thisimpliesthatcreditriskmustbeproperlyiden- tified,appraised,andeffectivelymitigated.Thismethodologicalframework,and theanalyticalfunctionsitembodies,pavesthewayforefficientstructuringofa creditfacility. Creditadministrationensuresthatthelendingportfolioisofhighquality, profitable, and effectively managed. This Pillar subsumes issues involved in enforcing credit control and compliance. Regular portfolio review, loan loss provisions, and internal credit ratings are some of the critical assignments impliedincreditadministrationfunctions. Loanrecoveryseeks,regularizes,andadoptsmeasurestoensurethatabank alwayshasefficientprocessesforloanworkouts,remediationofnonperforming loans,andtherecoveryofclassifiedorlostriskassets.Eachofthesefunctions inPillar3helpstoimprovethequalityofandreturnsonthecreditportfolio. The approach to and methodology for dealing with issues implied in the Pillarshavewitnessed dramatic changes over time. Yet, the goal of credit risk control remains immutable. Thegoal in question is addressed and largely ful- filledinthecontentofandexpatiationonPillar1. Aneffectiveprocessinthepursuitofriskidentification,riskanalysis,andrisk mitigationdallofwhichPillar1subsumesdholdsthekeytosuccessfullending. Striving toperfecttheselending criteriahasbeen, andwill continue tobe,the superstructure on which credit risk management hinges. One reason is that it definesamethodologythathasbecomecommonplace.Anotherreasonisthatit buildsonthehallowedlendingprinciplescommonlyreferredtoasthefiveCs. Thethirdreasonisthattheso-calledfiveCsoflendingalsounderliecreditrisk managementinpracticalterms.AfourthreasonisthatPillars2and3aresimply Preface xxiii postmortemsonPillar1.Besides,Pillar1informsactionslendingofficerstakein pursuit of Pillars 2 and3. Yet in order tobuilda quality lending portfolio, the three Pillars should function in independent capacities within the dictates of checks-and-balancesrules. However,workingrelationshipsamongthePillarsarescarcelywellorderedin banksinemergingeconomies,thusleavingroomforavoidablelapses.Indrawing theanalogybetweenapresidentialdemocracyandcreditriskcontrolinbanking,I make a case for the institutionalization of oversight of lending as a means of attainingqualityportfoliosinemergingeconomies. DEFINING THE PROBLEM Itisbadenoughthatregulatorstrydbutalltonoavaildtotametheexcessive risk appetites of banks. It is worse that reckless lending persists in banks and keeps the financial system on the edge of a precipice. Sadly, global financial crises in recent history originated in inefficient lending and failed risk man- agement. More worrying yet is that this quirk has become a recurring phe- nomenon.Mostdisturbingisthattheproblemisunlikelytogivewaywithouta seriousoverhaulofthemethodologyforriskmanagement.Ironically,thepursuit of this goalda foolproof credit risk management methodologydhas been an absolutenightmareforbankmanagementandregulators.Today,manyseecredit risk as a hotbed of reckless banking. More than ever before, the attention of bankingandfinanceexpertsaroundtheworldisnowfocusedoncreditrisk.The Basel Committee has led this cause with Basel I (1988), Basel II (2004), and BaselIII(2010).WhileBaselIdealtexclusivelywithcreditriskdtounderscore its importancedBasel II and Basel III advanced the cause even as they also focused on market, operational, and liquidity risks. Regrettably, crises in the globalfinancialsystemhaveneverbeenwellordered. Thefinancialcrisesofthe1970sand1980swerenotanticipated,aswasalso thecaseforthoseofthe 1990s.They caughtregulatorsandbank management completely unawares. Some of the emerging markets and regions that experi- enced crises included Latin America (1980s), Mexico (1994e1995), and Asia (1997e1998).Ineach case,thecrisisleftbitterlessons ofexperienceforgov- ernment,economists,andfinancialexperts,especiallybankmanagements.The bankingsystemsintheemergingmarketsofAfrica,Europe,andtheMiddleEast have suffered similar fates at one time or the other. In most cases, the crises becameacontagionandhadpracticalandcompellinglessons.Butforthelarge stockofnonperformingriskassetswithin thesebankingsystemportfolios,the tempoofthecrisesandmagnitudeofnationaleconomiclossesincurredbythe countries would have been manageable. Unfortunately, an unmanageable vol- umeofnonperformingriskassetstendstocauseliquiditypressureforbanksand makethemvulnerabletosuchsystemiccrises.Thefinancialcrisisof2007e2009 was the most embarrassing and lingered on for too long. The main culprit whenever financial crisis rocked the industry, especially in the 2007e2009 case,wasusuallycreditrisk.Oneachoccasionofcrisis,regulatorsfoundways xxiv Preface to rationalize a flawed supervisory framework in the wake of a crisis, while bank management prevaricated reckless lending. The public tends to distrust regulators and bank managements when authoritiesmakehollowexcusesforavoidablecrisis.Besides,failuretoantici- patecrisesimpingesonthesoundnessofthefinancialsystem.Often,aswouldbe expectedunderthecircumstances,apostmortemoneachcrisistriggeredsome regulatory response. Basel I addressed findings from the postmortem of the 1970sand1980scrises.Thepostmortemofthe1990scrisesinformedenactment ofBaselII.Inthemannerofitspredecessors,BaselIIIoriginatedinthe2007to 2009 financial crisis. Now, hopes are high that Basel Accords would address observedloopholesinthesupervisionofglobalbanks.Yetweshouldnotaccept thisoptimismuncriticallyorasagiven.SuccessoftheAccordsdependsonthe ingenuity that regulators bring to banking supervision. What is needed for the future is a moreand continuing proactive approach to credit risk. Withsuch a disposition,theauthoritiesandbankmanagementwouldcatchontocreditrisk and be able to forestall global financial crises. It would also help to temper financialcriseswhentheycannotbeavoided. REINVENTING CREDIT RISK CONTROL The need to reinvent credit risk control in emerging economies derives from observedflaws,highlightedthroughoutthisbook,thatnegateinternationalbest practices. But it is also founded on the need to strengthen the credit process, institutionalizetheriskcontrolculture,andimprovetheconductofbanklending inemerging economies.These require complete overhaulofthe current meth- odology for credit risk control. A critical issue is how best to devolve credit authorityandresponsibilitytolendingofficersandtoenforceaccountabilityfor recklesslending.Implicitinthisissueisthefactthattheinternalcreditprocess remainsameltingpot.Throughoutthebook,Idevelopananalyticalframework thatexplainsthefoundationoftheproblemandhowtoreinventthecreditpro- cess.Irelatetheproblemtoflawedriskcontrolandhighlightlessonsandfindings thatimpingeonthelendingfunction. STRUCTURE OF THE BOOK This book is a practical text for managing bank lending and credit risk in emergingeconomies.Itisenrichedwithcasestudiesandanalyses,aswellas empirical examples and illustrations. It equips bankers, deposit insurers, analysts,academics,andstudentswithanunderstandingoftheworkingsand outcomesofriskmanagementinbanklending.Thebookprofilescontempo- rarycreditriskcrises.Thesedefinetheproblemthattakescenterstageinthe book. Diagnosing credit risk as the canker of financial crisis in the banking system, it challenges management of credit risk in banks in emerging econ- omies. Using the framework of volatile markets, it discusses theoretical and practicalfoundationsoftheproblemwithimplicationsforbankmanagement. Preface xxv Thenitintroducesthewaysthatriskaffectscreditanalysisanddecisions.In doing so, itdiscusses howcreditrisk should be correctly anticipated, and its impactmitigated,withinaframeworkofsoundcreditcultureandprocessesin linewith the BaselAccords. Thebook is divided into four parts, comprising 10sectionsand38chapters.Eachchapterfeaturesanoverviewthatintroduces the subject of the chapter, its learning focus, and its outcomes. Chapters includereviewquestions. TARGET AUDIENCE The book targets bankers, deposit insurers, analysts, academics, and students indor interested indbanking in emerging economies. It solves five critical problemsforthetargetaudience.Theproblemsrelateto: l How to attain desired asset and portfolio quality through efficient lending and credit risk management in high-risk-prone emerging economies l A craving for a simple structure, devoid of complex models, for creating, assessing, and managing credit and portfolio risks in emerging economies l The dearth of practical books that specifically guide bankers through the analysis and management of the peculiar credit risks of counterparties in emerging economies l Confusing credit risk incidence, dynamics, and management requirements thatimpactanddetermineportfolioqualityandreturnsinemergingeconomies l TechnicalityofBaselAccordsandtherigorsoftheirpracticalapplications in risk-based supervision of deposit money banks (DMBs) in emerging economies. CRITICAL FUNCTIONS Thisbookfulfillsnumerousneedsforitstargetaudience.Itsmainfunctionscan besummarizedinunderstandingthatit: l Furnishes a structure for creating, assessing, and managing bank lending andcreditportfoliorisks,withaviewtooptimizingriskassetsqualityand portfolio returns in emerging economies l Distills the Basel Accords into a nontechnical guide to managing credit risk and building risk assets quality, and in doing so discusses the impli- cations and applicability of the Accords to the risk-based supervision of deposit money banks (DMBs) in emerging economies l Providesbankers,depositinsurers,analysts,academics,andstudentswitha practical understanding of credit risk incidence, dynamics, and manage- ment requirements tuned in to the need for optimum asset portfolios and returns in emerging economies. LeoOnyiriuba Lagos
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